| Tracking the two China spread |
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| 9.12.2007 | |
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A new index, launched by HSI Services in Hong Kong promises to be a highly useful proxy of investment flows from mainland China to Hong Kong. The Hang Seng A/H China Premium Index also has the potential to be an arbitrage trader's best friend. In the short term, however, capital controls will make it difficult to exploit valuation differences between the two stock exchanges. The Hang Seng A/H China Premium Index consists of the largest and most liquid mainland China blue chip companies with both A-share and H-share listings on two separate exchanges. Starting December 10, the index expanded from 34 to 35 companies. It includes such giants as Ping An Insurance, Air China, Anhui Conch, Huaneng Power and Bank of China. Mind the gap How did the difference in A and H shares come about? The A shares, which trade in mainland China, are mostly restricted to Chinese investors, while the same companies' H shares, which are listed in Hong Kong, have historically been available only to foreign investors. This restriction is modestly being lifted to allow domestic Chinese investors to hold stock on the Hong Kong stock exchange, and eventually in other overseas markets. An important driver is the excess liquidity fuelling the asset bubble in mainland China. In light of ballooning corporate and foreign exchange reserves, government policies are being designed to re-channel these funds outside mainland China (see related story). So far, the A-share market has been a beneficiary of capital controls, surging more than 100% during the first five months of 2007. "The gap will narrow in the long-term as A and H shares become fully tradable on both exchanges," says Major Teng, Chief Investment Advisor at Everbright Securities in Shanghai. "But this will take years. The gap will not disappear in the short-term, even if the government increases the quotas for mainland investors to purchase H-shares." For the time being, the pricing spread between the two remains significant. Vincent Kwan, director of HSI Services, says that the two markets operate under a different set of conditions and investors, helping to explain why the gap is not likely to disappear any time soon. On December 6, the class of A-shares, available only to domestic Chinese investors, traded on average at a 51% premium over H shares. (At 100, the two classes of shares trade at parity.) Looking at the companies in the index, some have benefited significantly from the boil in the mainland market. On November 30, for example, China South Air A-shares posted their biggest premium (200.8%) over H-shares; Ping An Insurance posted a 39.4% premium, while Anhui Conch recorded the smallest (5.1%). "What we have observed is that large movements in the index are effected by policy statements," says Kwan. On August 20, for example, the government announced that mainland individual investors could buy Hong Kong shares. Within a day, the spread narrowed 400bp. "We also see large moves on rumours or when they subsequently turn out to be unfounded." History of two markets The back-tested data of the index presents interesting patterns. Hong Kong-based HSI provided bfinance with a historical time series from January 2006, 18 months before the actual launch of the index. A-shares traded at a discount to Hong Kong H-shares in the first four months of 2006 (the index stood at 88.7 on May 2.) In the following months a reversal began to develop and demand for mainland companies increased. The buoyant market has historically received a boost from investor restrictions to hold foreign-listed stocks; as a result more funds have been allocated to A-shares. The valuation gap between the two markets was eventually eliminated and A-shares started to handily out-perform H-shares starting a year ago. The index hit a high on August 17, with A-shares trading at an 83.7% premium, propelled by a sharp sell-off in the Hong Kong market. The spread has since come in following moves to allow domestic investors to purchase stocks in Hong Kong (see related story), with potentially important long-term ramifications for the A-shares market, but also for the H-shares that foreign investors can hold. VB |
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